Stress Testing The World Economy With Network Simulation

A group of mathematicians use some unusual methods (i.e. not econometrics) to "stress test" the global economy (via MIT Technology Review). Dan Rockmore & Co developed a world trade web (WTW) to investigate the robustness of the global economic system using extinction analysis, the sort of analysis which is common in the study of ecosystem.

I don't think you can take this as some sort of economic forecast, though their methods and some of their findings are quite interesting.

On of the essential findings is that China is really important. In the network, they simulated a 5% drop of exports and 30% drop of imports for various countries (which was what happened to Thailand during the Asian Financial Crisis), and this is what they found:

… large players in international trade have, in general, the largest impact, with the China, Germany, the United States, Japan and France playing central roles. Indeed, this perturbation of China creates substantial global impact according to this model, causing at least a 1% drop in income for 94% of countries

Basically it tells us that if China's economy slows significantly, the rest of the world will suffer. That should, of course, be not surprising to anyone.

The paper is very technical, though the results are quite thought-provoking. The abstract reads:

The World Trade Web (WTW) is a weighted network whose nodes correspond to countries with edge weights reflecting the value of imports and/or exports between countries. In this paper we introduce to this macroeconomic system the notion of extinction analysis, a technique often used in the analysis of ecosystems, for the purposes of investigating the robustness of this network. In particular, we subject the WTW to a principled set of in silico "knockout experiments," akin to those carried out in the investigation of food webs, but suitably adapted to this macroeconomic network. Broadly, our experiments show that over time the WTW moves to a "robust yet fragile" configuration where is it robust under random attacks but fragile under targeted attack. This change in stability is highly correlated with the connectance of the network. Moreover, there is evidence of sharp change in the structure of the network in the 1960s and 1970s, where the most measures of robustness rapidly increase before resuming a declining trend. We interpret these results in the context in the post-World War II move towards globalization. Globalization coincides with the sharp increase in robustness but also with a rise in those measures (e.g., connectance and trade imbalances) which correlate with decreases in robustness. The peak of robustness is reached after the onset of globalization policy but before the negative impacts are substantial. In this way we anticipate that knockout experiments like these can play an important role in the evaluation of the stability of economic systems.